Saturday, July 05, 2008

Zero-intelligence investors

Whenever the Sensex dips a bit, the papers carry a photograph, the next day, of shell-shocked traders staring disbelievingly at the screen in front of them and watching the prices slide rapidly before their eyes. My usual reaction is, “Good. Serves the idiots right”. A system where stock prices don’t correlate with the fundamentals or the technical parameters is as good as a lottery to me.

In fact, the only correlation that I could discern, before I got over the madness, was that the Sensex would unfailingly rise, a few minutes after I had sold off some shares, and tumble a few minutes after I had bought some shares. In a manner of speaking, I was cross-subsidizing the Stock Market.

Jeffrey Kluger, author of the book “Simplexity”, writes about the ways of the stock market:

Never mind what you think about the exquisitely complex organism that is the world’s financial market. Never mind the hundreds of millions of thoughtful investors and their billions of well-considered trades. For every market analyst who sees traders as the informed and educated people they surely can be, there are scientists who see them another way entirely; as atoms in a box, billiard balls on a table, unthinking actors who obey not so much the laws of economics, as the laws of physics. The things that result from those actions may be undeniably extraordinary- the creation or destruction of trillions of dollars of wealth in a matter of hours- but down at the fine-grained level at which the transactions are made, the players themselves can be remarkably simple things.

..When the tide of the market shifts, most of us shift with it; when it flows back, the other way , we do the same. We like to think we are informed by trends, but often as not, we’re simply misled by them, snookered by what everyone else is doing into concluding that we ought to do the same.

..Economic models always begin with the assumption of perfect rationality, of a universe of logical people, all doing what they can to master their utility. But, physicists studying economics begin with the assumption that people can’t think.

I agree with the physicists. When a Ponzi scheme is exposed, one is always amazed, in hindsight, at the fact that so many seemingly sensible people allowed themselves to be conned.

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